May 3, 2010

ACTION ALERT: Urge Senators to Fix Swaps Legislation

Action Requested:
Please contact all Senators with whom you have a material constituent relationship, particularly members of the Democratic leadership, to urge a fix to the "swaps/fiduciary" provision currently being considered as part of the financial services reform bill. In addition, this issue has risen in profile within the Administration. So if your company/firm has a strong relationship within the White House, Labor Department, Treasury Department, or Commodity Futures Trading Commission, please reach out to those individuals.

Use the Council's Capitol Connection Center to enter your zip code and obtain phone information for your current Senators. Additional contact information is listed below.

The U.S. Senate is currently considering the Restoring American Financial Stability Act (S. 3217), sweeping financial services reform legislation that would, among other things, regulate so-called "swap trades," financial instruments that plans use to manage and reduce risk, especially interest rate risk, currency risk, and rebalancing challenges. On April 21, lawmakers on the Senate Agriculture, Nutrition and Forestry Committee approved the Wall Street Transparency and Accountability Act, which has been folded into the text of S. 3217.

The key issue now being discussed with respect to retirement plans — both defined contribution and defined benefit plans — is a requirement that if a swap dealer offers to enter into a swap with a plan, the swap dealer has a fiduciary duty to the plan. The motivation of the provision was to protect plans. There is a concern in Congress that sophisticated swap dealers can take advantage of less sophisticated plans and cause the plan to enter into a disadvantageous swap. Obviously, protecting plans is a worthy goal. But this provision — as modified yesterday — does just the opposite.

Under this provision, a swap dealer would have a fiduciary duty to a plan similar to the fiduciary duty owed by a registered investment adviser under the Investment Advisers Act of 1940. This would mean that the swap dealer would have a duty of loyalty to the plan and would be required to act in the best interests of the plan. Under this requirement, the swap dealer would be required to act on behalf of both parties to a transaction in negotiating price and terms and whether to enter into the transaction. This is clearly not workable. A swap dealer cannot owe a duty of loyalty to both sides of a transaction. Accordingly, swap dealers are saying that they cannot enter into swaps with plans. And they are right in their analysis.

401(k) Stable Value Funds are Threatened: Stable value funds would be very severely affected by the bill. Under the bill's very broad definition of a swap, the guarantee issued in connection with a stable value fund can be a swap. Under the fiduciary provision, issuers of these guarantee arrangements would be effectively forced to cease issuing the guarantees to plans. Otherwise, the swap dealer issuing the guarantee to a plan would be representing both itself and the plan. Since stable value funds are extremely common in 401(k) plans and provide protection against market fluctuation combined with a reasonable rate of return, the loss of stable value options nationally could be extremely harmful and disruptive.

DB Plan Investment Risk Management Strategies are Threatened: The effects of making swaps unavailable to defined benefit plans would be devastating. Large defined benefit plans use swaps to manage risk, especially interest rate risk. Taking away this tool will trigger much more asset and funding volatility. More funding volatility requires companies to set aside larger reserves to address future funding obligations, thus taking money away from job retention and economic recovery.

Policy Discussions:
The Council has been engaged in numerous ongoing discussions with key Congressional offices, as well a meeting and many discussions with officials from the Department of Labor. The Department of Labor officials maintain that the legislation does not raise ERISA issues. Their position is based on the view that the fiduciary duty required under the bill is less expansive than an ERISA fiduciary duty, and thus fulfilling the fiduciary duty under the bill will not trigger ERISA fiduciary status. Congress is interpreting this message from the DOL as indicating that the fiduciary provision does not cause any problems for plans. This is incorrect for two reasons. First, even if there is no ERISA problem under the bill, the swap dealer would still have a fundamental conflict of interest and would not be able to represent both sides of the transaction.

Second, there are many legal advisors who have raised questions as to how they can rely on the unpublished and informal DOL view. Under the bill, swap dealers entering into a swap with a plan would have a fiduciary duty to the plan. Under the investment adviser fiduciary principles, this duty would entail at least a duty of loyalty to act in the best interests in the plan. With respect to a transaction like a swap, it seems very likely that the nature of the fiduciary duty would be to advise the plan regarding (1) whether to enter into this swap or a different swap, (2) the price of the swap, and (3) the terms of the swap, including collateral. This advice could extend over a period of time as the plan explores its various options.

In short, under a very reasonable interpretation of the provision, the swap dealer would, pursuant to a duty of loyalty to the plan, be providing advice to the plan regarding a series of critical investment issues over a period of time. Legal advisors are concerned that without formal guidance confirming the DOL position, courts could have difficulty concluding that the swap dealer was not an ERISA fiduciary in these circumstances. Of course, if the swap dealer is an ERISA fiduciary, entering into the swap would be a prohibited transaction, because of the swap dealer's conflict of interest.

The Senate, the White House, the Treasury Department, the Commodity Futures Trading Commission, and the Department of Labor need to know that this well-intentioned provision would actually have severely adverse effects on plans by taking away an essential risk management tool from defined benefit plans and by undermining a very common 401(k) plan investment. We need to inform the government that this provision actually hurts plans very badly and must be removed from the bill.

Talking Points:

  • Both defined contribution and defined benefit pension plans use swaps to mitigate and reduce risk, and thereby control plan asset volatility. If swaps are unavailable to plans, plan asset volatility will increase markedly. This in turn will make funding obligations for defined benefit plans far more unpredictable. If funding obligations become more unpredictable, companies will need to reserve larger amounts to ensure that they will have enough money to meet their funding obligations. Larger reserves mean less money for job retention, less money for investment in the economic recovery, and less money for benefits for employees. Plans also use swaps to allow constant dollar trading in stable value funds, which are an extremely popular and valuable option in 401(k) plans.

  • Under the legislation, many stable value investment options will likely be terminated. These are offered as investment options in defined contribution plans and utilize swaps to maintain their value. Termination of these options will force millions of individuals to change investments. Currently, 60 percent of all defined contribution plans include a stable value option in their menu.

  • Under the legislation, defined benefit plans will not be able to manage investment risk by entering into liability matching investment strategies. Governments and pension plans (and their investment advisers) will not be able to prudently manage risk and will be unable to engage in prudent transactions that are in the interests of the plan and its participants.

Please Help:
Use the Council's Capitol Connection Center to identify elected Senators from your key states and districts and urge their support for a retirement plan fiduciary carve-out.

Of particular importance are the following Senators:

  • Harry Reid (D-NV), Senate Majority Leader
  • Richard Durbin (D-IL), Senate Majority Whip
  • Christopher Dodd (D-CT), Chairman, Senate Banking, Housing and Urban Affairs Committee and lead sponsor of S. 3217
  • Blanche Lincoln (D-AR), Chair, Senate Agriculture, Nutrition and Forestry Committee and cosponsor of S. 3217

Contact key Administration officials.

Of particular importance:

Jason Furman, Deputy Assistant to the President for Economic Policy and Deputy
Director, National Economic Council

Phyllis Borzi, Assistant Secretary for Employee Benefits Security, Department of Labor

Michael Davis, Deputy Assistant Secretary for Employee Benefits Security, Department of Labor

Michael Barr, Assistant Secretary for Financial Institutions, Treasury Department

Mark Iwry, Senior Advisor to the Secretary and Deputy Assistant Secretary for Retirement and Health Policy, Treasury Department

Eric Juzenas, Senior Counsel to the Chariman, Commodity Futures Trading Commission

Cyrus Amir Mokri, Senior Counsel to the Chairman, Commodity Futures Trading Commission

Dan Berkovitz, General Counsel, Commodity Futures Trading Commission

John Riley, Director Office of Legislative Affairs, Commodity Futures Trading Commission

For More Information:
For more information, please contact Diann Howland, vice president, legislative affairs, or Jill Randolph, director, legislative and political affairs, at (202) 289-6700.